tailieunhanh - Understanding Corporate Bond Spreads Using Credit Default Swaps

Much of the resistance in debt restructuring comes from the fear that restructuring will effectively be a bailout by countries of tighter fiscal discipline to countries with less fiscal discipline, and the moral hazard that this implies. The fear is that countries’ “bad” behavior in overspending and accumulating debt will be rewarded through a government bailout. In contrast to such a restructuring, there is no bailout associated with Trichet bonds. Old bonds will be exchanged at present market prices. The debtor does not receive higher value than what the present bonds are worth other than modest incentives designed to encourage participation in the exchange | Understanding Corporate Bond Spreads Using Credit Default Swaps Alejandro Garcia and Jun Yang Financial Markets Department Since the beginning of the credit crisis spreads on corporate bonds the difference between the yields on a corporate bond and a government bond with identical cash flows worldwide have widened markedly. This article decomposes Canadian corporate spreads into default and liquidity components for selected Canadian firms using a model that extracts default information from credit default swaps. During the credit crisis in 2008 the liquidity component for speculative-grade bonds increased earlier than it did for investment-grade bonds which is consistent with a flight-to-qual-ity scenario. Although the results are based on a small sample of Canadian firms they are consistent with recent research on how liquidity risk is priced in corporate bond markets. Since the beginning of the credit crisis in mid-2007 corporate spreads worldwide widened markedly. In Canada the aggregate spread for investment-grade firms reached a maximum of 401 basis points bps in January and March of 2009 substantially more than the historical average of 92 bps the spread on the equivalent index in the United States reached 656 bps in December 2008 also substantially more than its historical average of 153 bps Chart 1 .1 Owing to the problems in funding markets corporations and financial institutions began to replace risky assets with safer ones this flight-to-quality effect resulted in large price declines in equity and corporate bond markets and increases in prices in the government market. In this article the corporate bond spread is defined as the difference between the yields on a corporate bond and a government bond with identical cash flows. Under this definition the corporate spread reflects the additional compensation required by investors to hold the corporate bond compared with the return on the default-free asset the government bond . This additional yield .

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